Banks are set to increase substantially the amount of government debt they buy next year, easing fears that countries that spent billions bailing many of them out during the financial crisis would find difficulty footing the bill.

Governments, which provided $663bn (€447bn) in capital to banks crippled by the financial crisis, and even more in liquidity programmes, will next year be forced to raise record amounts of debt to help pay for the bailouts. This has led to concerns about a lack of sufficient appetite for the burgeoning supply.

However, in a stark reversal of the traditional role, where central bank authorities act as lenders of last resort to the banks, the banks themselves will soak up much of the debt that governments issue, thanks to changes in the regulatory landscape which will force them to hold more government bonds.

Banks are likely to need to increase their purchase of government debt because regulators will force them to hold more liquid assets. Analysts at Credit Suisse said that if US banks were to increase their holdings of government bonds from the current 11% of assets to 20%, the level seen the last time western economies emerged from recession in 1993, they would have to buy about $1.1 trillion worth of bonds. That would be enough to fund nearly two thirds of the US Government’s budget deficit projected for 2010.

Analysts at HSBC estimate banks could buy as much as £110bn in UK gilts, or 60% of expected new issuance next year and even more in subsequent years, as a result of the need to invest a greater proportion of their assets in liquid government bonds. “Bank demand for gilts is likely to siphon off a large proportion of supply over the next few years at least,” wrote the HSBC analysts in research published last month.

Debt bankers and traders said the dominant factor expected to drive bank purchases of government bonds next year would be new regulatory demands. Clement Perrette, head of European rates trading at Barclays Capital in London, said banks were expected to increase their term funding under the Financial Services Authority’s new liquidity requirements. “To build those reserves, they’ll need to hold more government bonds,” he said.

Nimesh Verma, part of the financial institutions advisory team at BNP Paribas in London, said: “What is clear is that banks will be expected to hold more government paper. They are expected to have stronger liquidity buffers, and the requirement that it is in government paper form could cynically be construed as back-door taxation on the banking system, to absorb the growing issuance of government debt.”

The FSA has been the most prescriptive in setting new liquidity requirements, which it tabled in October. However the Basel Committee on Banking Supervision is also expected to address the issue at its meeting this week.

Banks pile into government bonds when the yield curve is steep, that is, when long-term rates are significantly higher than short-term rates, as is currently the case. Credit Suisse analysts wrote in research published last week: “With the yield curve as steep as it was in 1993, loan growth weak, and regulatory and liquidity requirements pushing banks to buy more bonds, it seems probable that banks will be the governments’ lenders of last resort.”

Governments in the eurozone are next year expected to issue €1 trillion ($1.5 trillion) in bonds, up from €900bn this year and €636bn last year, according to HSBC. Similarly, the US Federal Reserve is expected to bring $2.4 trillion in fresh supply to the markets for the 2009/2010 fiscal year, up from $1.8 trillion in the 2008/2009 year. The Debt Management Office in the UK has said it expects to issue £220bn in the 2009/2010 fiscal year, up from £147bn in the 2008/2009 year.